The International Who’s Who of Real Estate Lawyers has brought together two of the world’s leading practitioners to discuss key issues facing real estate lawyers today.
Jane Snoddy Smith
Fulbright & Jaworski LLP
It has been reported that advisory work and litigation in real estate have grown in prominence given that there have been fewer transactions since the economic downturn. If this is the case in your market, how have you adapted your practice to match this trend?
Jane Snoddy Smith: We have observed a marked increase in contested loan enforcement. In addition we have seen an increase in arbitration of fair market rent for retail tenants where several years ago we would have expected these matters to be settled. The inability of the parties to settle these matters is derived from the increased operating costs (especially real estate taxes and insurance) incurred by landlords and the flat to lower sales achieved by the retail tenants. Also, many properties were bought before the downturn in property values. As rental rates have decreased and vacancies have not, expectations of return on investment may not be realised in the near term, if ever. In this setting any seller misrepresentations or any defects in title or the improvements have a greater impact on property value. Where there is less profit there is little or no cushion to offset the unexpected. The magnitude of the harm can justify pursing the dispute. We have paired dispute and transactional attorneys to provide clients with a comprehensive strategy.
Michael Henderson: In the past four years there has definitely been an upturn in the number of disputes as parties seek to enforce contracts or evade liability. We have seen many more disputes ending up in court. Previously some of these would have been the subject of negotiated settlements in advance of court proceedings. Contentious and non-contentious property lawyers will work hand in hand with each other to provide the best service to our clients. To facilitate this we’ve co-located our contentious and non-contentious lawyers within the office.
This time last year there was a general consensus that the real estate market was beginning to pick up and would continue an upward trend over the coming few years. How has that prediction borne out in your jurisdiction?
Michael Henderson: Transactional activity continues with some significant new lettings and concerns for the supply of offices in the central business districts of key cities. Concerns over the eurozone and the UK economy are well-documented elsewhere. Occupiers will need to be confident of a stable environment for economic growth, which will in turn drive investment in their businesses and ultimately growth in their occupational requirements going forward. The UK does remain an attractive market for foreign investors as can be seen from recent investment activity.
Jane Snoddy Smith: The answer is that certain segments, such as multi-family, have enjoyed an increase. Retail transactions have seen a slight increase in activity, especially in upscale and discount retail, and office leasing may be lagging. This activity, however, has not translated into an overall upward trend. Transactions take more time and effort to close so there is more consistent activity but on fewer matters.
The single most prominent topic across the course of our research has been financing and/or the lack thereof. What trends have you seen in this area and are there any new financing models coming into play?
Michael Henderson: There is a significant number of insurance companies and fund managers who have declared their interest in lending to the property market. While this is encouraging, the amount of finance available represents only a fraction of debt to be refinanced in the coming years. I would be surprised if the lending criteria are anything other than conservative. Development finance on acceptable terms remains scarce. There has been a resurgence in the use of forward funding to finance selected developments pre-let to blue-chip tenants. We could see more joint ventures as developers spread their risk and pool equity in order to raise debt for future projects.
Jane Snoddy Smith: The overhang of loans coming due for renewal or refinance is still a factor. The ability to extend existing debt is a key strategy to avoid or at least postpone the infusion of more equity to meet lower loan to value requirements. There is concern about the impact of new regulations under Dodd-Frank, where issuers must retain 5 per cent of the credit risk of non-qualified assets and loan or asset-level disclosures must be made. Bank and institutional financing now is generally available for well-leased, CBD products. However, the underwriting standards are still much stricter than they were prior to 2008, requiring 60 to 65 per cent loan to equity or higher. Assumptions of existing debt can be as lengthy and difficult as new loan originations. Commercial banks because of regulation changes require two sources of repayment. Construction financing for new, speculative development is still very difficult to find. In ventures where there is a strong investor member, construction loans are available so long as there is a completion and cost overrun guarantee from a credit worthy guarantor, and all development entitlements and permitting are achieved.
Many of the lawyers we have spoken to describe a demand for core products such as retail centres which are simply not available. How is this reflected in your jurisdiction and do you have any predictions for when such assets might start to come on to the market?
Jane Snoddy Smith: Because a core property has a quality and proven rent stream, it is especially attractive in a frequently changing and unpredictable global economy. Areas that have not experienced a drop in demand for goods and services, and where employment remains relatively high with little reduction in wages, have managed to lower (somewhat) vacancy rates. There are diverse sub-markets within a metropolitan area and industry categories. For example, in the energy corridor, the energy companies are expanding rapidly. Downtown, where service industries are typically located (lawyers, accountants, etc), the market tends to be softer. Markets are also more attractive where there is a perception of a business-friendly environment with lower taxation and regulation. Barriers to entry for new construction can make existing properties more highly valued. The key to availability in these markets, however, is pricing. Pricing is driven by the current low interest rate environment and makes many acquisitions not suitable for institutional investors. We are seeing transactions in core multi-family properties, especially in select urban infill locations. As enough of the existing product has not been available in desired locations, there is an increase in acquisition and construction of new multi-family development sites. Retail transactions are also active. While there is some decline in consumer spending, spending appears to be concentrated in either luxury or discount retail. New high-end grocery stores are being built in older neighbourhoods experiencing a revival or gentrification. Some properties are trading in off-market transactions at aggressive prices, or are lingering on the market while the seller waits for a more acceptable price. Some institutional investors have acquired an interest in core properties by providing the equity needed to bridge the gap between the amount of maturing debt and the amount that can be refinanced at current loan-to-value ratios. This provides both a preferred return and the right to participate in the increase in value of the asset over time. We are also seeing a trend in portfolio transactions which may allow the seller an exit strategy for some underperforming assets by pairing them with core properties. The buyer may achieve a price advantage and spread its risk over a larger pool of properties. Increasingly, these portfolio transactions involve the purchase and enforcement of distressed debt as a means to acquire properties. In addition, there are time and cost efficiencies with these portfolio transactions that cannot be achieved over a series of single asset acquisitions or dispositions. As ownership of more commercial real estate is concentrated in fewer companies, it is easier to make these large portfolio trades.
Michael Henderson: There is always going to be demand for prime property which is well located and let to sound tenants on long leases. However, the banks have control of a lot of properties which do not tick all these boxes. Recently a number of secondary assets have sold as owners become more realistic on pricing. Over the past year loan portfolios have been sold by the banks and we are starting to see sales of the underlying properties to realise value. This trend will continue for the foreseeable future. I also anticipate more lease regears in advance of sales as sellers seek to maximise investment values